NYU's Sargent awarded Nobel

[Dave Backus @ NYU]

NYU’s Tom Sargent, a joint appointment between Stern and Arts and
Science, was awarded the “Sveriges Riksbank Prize in Economic Sciences
in Memory of Alfred Nobel” this morning, together with Chris Sims of
Princeton. Sargent and Sims were part of an unusually strong group of
young macroeconomists at the University of Minnesota in the 1970s,
which included Ed Prescott (2004 Nobelist) and Neil Wallace (perhaps
the world’s leading monetary theorist). They worked separately, for
the most part, but it’s easy to see influences among them. For
decades their students have continued “the Minnesota tradition” all
over the world, including NYU and Princeton. Chicago’s Lars Hansen is
the most prominent, with enormously influential work on the interface
of macroeconomics and finance. No one would have been surprised if
he’d been included in this prize.

So what did they do? Their work was aimed at specialists, but let me
give it a try. The most important thing they did was develop language
and tools for thinking about dynamic macroeconomic models and linking
them to data. In some ways, this line of work took tools from applied
mathematics to and applied them to economics, but the change in
perspective had a huge influence on macroeconomics. If you start (as
many still do) with some kind of supply and demand diagram, then
prices and quantities depend on where the curves intersect (supply
equals demand!). But in dynamic settings, your decision today depends
on what you expect to happen in the future. Should I buy a computer
today or wait for the price to fall? That brings in expectations in a
central way: what you expect to happen in the future affects what you
do today. The same logic applies to practical issues like monetary
and tax policy. The Fed recently announced not only its current
policy but its intentions for future policy precisely to make the
future clearer to firms and workers. If only we had the same
certainty about future US tax policy!

The next question is how to link dynamic models to data. There’s a
fundamental issue in macroeconomics about identifying causality. If
(say) the Fed raises the interest rate and economic growth slows down,
do we have cause and effect? Or would the economy have slowed down
anyway? It’s a fundamentally difficult problem because we don’t have
a controlled experiment: we can run history over again with different
Fed policy. In some of their work, they illustrated the difficulties
-- in some cases coming close to saying the problem is impossible. In
others, they outlined constructive attacks on the problem: using
information about timing, apply enough economic structure to make
causality clear, develop models with minimal structure and see what
happens. It’s technical work, but part of everyone’s toolkit
today.

Another line of work concerns the difficulty of nailing down
expectations. Tom and Chris’s initial work was based on “rational
expectations”: that people would use all the available information
effectively in forecasting the future. But what if people aren’t sure
what’s going on? Or can’t figure out how to use the information they
have? Their work is filled with interesting ideas for how to handle
these situations, too. One idea is learning: people know something
about the world but need to learn the rest, and while they’re learning
they may make lots of mistakes. Some of Tim Cogley’s research fits
into this category. Another idea is that people can process limited
amounts of information at a time. Laura Veldkamp’s work is a good
example. A third is that people may choose to protect themselves
against things they don’t know: that they face “ambiguous” situations
and do their best to avoid the worst-case scenarios. These lines of
research are at the forefront of modern economics, something of a
rarity when prizes are awarded for work done decades ago.

One last thought about Tom. He’s devoted to his students, past and
present. He has supervised dozens, maybe hundreds of PhD students,
and inspired many more. Stan Zin and I think of ourselves as Tom’s
students once removed, since we learned much of what we know from his
books. He’s also taught several generations of undergraduates, many
of whom found it a transforming experience. All of us have inherited
from him a passion for doing economics and a dedication to “doing it
right.”

Announcement: http://www.nobelprize.org/nobel_prizes/economics/laureates/2011/
Interview: https://files.nyu.edu/ts43/public/personal/sargent_Mpls_interview.pdf